Free Cash Flow Valuation Flashcards
What is free cash flow?
- cash flows available for distribution
When is FCFF or FCFE discount model preferred?
- company does not pay dividends
- dividends are not reflective of the dividend capacity
- forecasted free cash flows align with profitability
- investor takes a control perspective
What is the difference between FCFF & FCFE?
- FCFF: cash flow available to all capital providers after payments for operating expense, working capital investments, and fixed capital (CFO - capital expenditures)
- FCFE: FCFF minus payments to debt holders (cash flow available to equity providers)
What is formula for equity value and for firm value using present value of FCFF?
firm value = FCFFt / (1+WACC)^t
FCFF = free cash flow to firm
WACC = weighted average cost of capital
equity value = firm value - market value of debt
What is formula for WACC using present value of FCFF?
WACC = ([MV of Debt/ MV of Debt + MV of Equity] * (rd * (1-tax rate)))+ ([MV of Equity / MV of Debt + MV of Equity] *re)
rd = cost of debt or rate of debt
re = cost of equity or rate of equity
What is formula for equity value using present value of FCFE?
equity value = FCFEt / (1+r)^t
FCFE = free cash flow to equity
r = discount rate or required rate of return
t = time
What is formula for firm value and FCFF using single stage constant growth FCFF valuation model?
FCFF1 = FCFF0 * (1+g)
FCFF1 = free cash flow to firm in 1 year
FCFF0 = free cash flow to firm now
g = constant growth rate
Firm value = FCFF1 / (WACC-g)
WACC = weighted average cost of capital
What is formula for equity value and FCFE using single stage constant growth FCFE valuation model?
FCFE1 = FCFF0 * (1+g)
FCFE1 = free cash flow to equity in 1 year
FCFF0 = free cash flow to equity now
g = constant growth rate
equity value = FCFE1 / r-g
What is formula for FCFF from net income?
FCFF = NI + NCC + (INT*(1-tax rate)) - FCinv -WCinv
NI = net income
NCC = non cash charges
Int = interest expense
FCinv = investment in fixed capital
WCinv = investment in working capital
What is formula for FCFF from statement of cash flows? What is the formula for statement of cash flows used in calculation of FCFF?
FCFF = CFO + (Int * (1-tax rate)) - FCinv
CFO = cash flow from operating activities
Int = interest expense
FCInv = investment in fixed capital
CFO = NI + NCC - WCInv
NI = net income
NCC = non cash charges
WCinv = investment in working capital
What are 6 non cash items that need to be added back to NI when calculating FCFF?
- depreciation/amortization
- impairment of intangibles
- restructuring charges
- losses
- amortization of long term bond discounts
- deferred taxes
What are 3 non cash items that need to be subtracted from NI when calculating FCFF?
- expense reversals
- gains
- amortization of long term bond premiums
What is the formula to calculate FCFE from FCFF?
FCFE = FCFF - (Int * (1-tax rate)) + net borrowing
FCFF = free cash flow to firm
net borrowing = long term debt
What is the formula to calculate FCFE from NI and CFO?
FCFE = NI + NCC - FCinv - WCinv + net borrowing
NI = net income
NCC = non cash charges
FCinv = investment in fixed capital
WCinv = investment in working capital
Net borrowing = different in long term debt
FCFE = CFO - FCinv + net borrowing
CFO = cash flow from operations
How should firms with a bunch of non operating assets be valued and what are examples of non-operating assets?
- firms with significant non-operating assets should be valued as the total value of all of their assets, not just their operating assets (important for calculating CFO, which is cash flow from operations)
examples:
- Excess” cash and marketable securities
- Non-current investments in stocks and bonds
- Land held for investment
- Pension surplus
What is formula for firm value using 2 stage free cash flow models?
firm value = (FCFFt / ((1+WACC)^t)) + {(FCFFn +1 / WACC-g) * (1/(1+WACC)^n)}
What is the formula for calculating FCFF from EBIT and what is the formula for EBIT?
FCFF = (EBIT * (1-t))+ DEP - FCinv - WCinv
EBIT = earnings before tax
T = marginal tax rate
DEP = depreciation
FCinv = investment in fixed capital
WCinv = investment in working capital
EBIT = NI + (interest * (1-t)) / 1-t
What is the formula for calculating FCFF from EBITDA?
FCFF = (EBITDA * (1-t)) + dep(t) -FCinv -WCinv
EBITDA = earnings before interest, taxes, decoration, & amortization
t = tax rate
Dep = depreciation
FCinv = investment in fixed capital
WCinv = investment in working capital
What are the 3 basic uses of FCFF?
- retain funds (increase cash balance)
- pay providers of debt capital (interest & principal payments
- pay providers of equity capital (dividends & share repurchases)
What is the formula for calculating FCFF from its uses?
FCFF = increase in cash balance + (interest expense * (1- tax rate)) + debt repayment + cash dividends + share repurchase
What is the formula for calculating FCFE from its uses?
FCFE = increase in cash balance + cash dividends + share repurchase
What is the formula for a sales based forecast on FCFF?
FCFF = (EBIT*(1-tax rate)) - (FCInv - Dep) - WCinv
FCinv - Dep = incremental fixed capital expenditure net of depreciation
WCinv = incremental working capital expenditures
What is the 3 step process for estimating (FCinv-Dep) and WCinv when performing a sales based forecast for FCFF?
- Forecast constant growth rate for sales
- multiple (FCinv-dep) and WCinv with the constant growth rate for sales to find the new incremental increase for (FCinv-dep) and WCinv (use the following formulas)
FCinv-dep increase = capital expenditures - depreciation expense /increase in sales
WCinv = increase in working capital / increase in sales
- plug in new figures into formula for FCFF using sales based forecast
What is formula for FCFE is we assume that a company will adjust its capital structure to a target debt ratio?
FCFE = NI - ((1-DR)(FCinv-Dep)) - ((1-DR)WCinv)
NI = net income
DR = target debt ratio
FCinv = investment in fixed capital
WCinv = investment in working capital
What is formula for FCFF is company has preferred stock?
FCFF = NI + NCC + (Int* (1-tax rate)) + preferred dividends - FCinv - WCinv
NI = net income
NCC = non cash charges
FCinv = investment in fixed capital
WCinv = investment in working capital
What is formula for required rate of return for an international application of single stage model?
r = country return +industry adjustment +size adjustment +leverage adjustment
r = real required rate of return
What is the formula for valuing a company using real rates?
V0 =FCFE0 *(1+greal) / (rreal - greal)
g real = growth rate of real return
r real = required rate of real return
What is formula of for value of firm using sensitivity analysis?
V0 = FCFE0 * (1+g) / [risk free rate + B(equity risk premium)] - g
B = beta
Equity risk premium = return of market - risk free rate
What does free cash flow valuations focus on?
Free cash flow valuations focus on assets that generate operating cash flows.
How should firms with significant non-operating assets be valued, and what are non-operating assets?
Firms with significant non-operating assets should be valued as the total value of all of their assets, not just their operating assets.
Examples of non-operating assets include:
- “Excess” cash and marketable securities (i.e., more than is needed to facilitate ordinary operating activities)
- Non-current investments in stocks and bonds
- Land held for investment
- Pension surplus
What needs to happen for valuation purposes if non-operating assets are being carried at book value?
Any non-operating assets that are being carried at book value should be adjusted to their market value for valuation purposes.
